Thursday, September 17, 2009

IOSCO Publishes Elements of Regulatory Standards for Funds of Hedge Funds

On September 14, 2009, the Technical Committee of the International Organization of Securities Commissions ("IOSCO") published its Final Report on Elements of International Regulatory Standards on Funds of Hedge Funds Related Issues Based on Best Market Practices (the "Report"). The Report provides guidance to managers of funds of hedge funds regarding their liquidity risk management and due diligence policies, two areas seen as requiring additional investor protection regulation.

The Report recommends four broad methods for funds of hedge funds' managers to better manage liquidity risks. Managers are encouraged to consider (i) the consistency of the liquidity profiles of the fund of hedge funds and the underlying hedge funds; (ii) the liquidity of the investments held by the underlying hedge funds prior to investing and thereafter on an ongoing basis; (iii) whether the introduction of limited redemption arrangements would be consistent with the fund's aims and objectives and in compliance with certain proposed conditions; and (iv) whether any conflicts of interest may arise between the underlying hedge funds and any relevant party.

The Report's guidelines require a fund of hedge funds' manager to establish due diligence processes with regard to (i) elements to be constantly monitored and analyzed by funds of hedge funds’ managers (including, inter alia, the appropriateness of the legal regime and service providers, and the transparency, valuation and reporting arrangements of a specific hedge fund); (ii) the resources, procedures and organizational structures that the manager could be required to have in order to carry out appropriate due diligence; and (iii) the conditions for authorizing the outsourcing of due diligence.

The standards suggested by the Report are not meant to be comprehensive and are not legally binding. However, they do reflect the common views of the IOSCO members on the subject, and might serve as an indication for future regulation.